Edward Price is principal at Ergo Consulting. A former British trade official, he also teaches at New York University’s Center for Global Affairs.
How fascinating it is that Bernanke, Diamond and Dybvig won Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel — and how super fascinating that they won it together.
There’s good reason of course. Diamond and Dybvig’s 1983 paper was the first real model of its kind. Its explanation of sunspot bank runs is genius. Diamond and Dybvig are geniuses. Meanwhile Ben Bernanke (plus Mervyn King, US Treasury officials and, frankly, Vishnu the Preserver) saved the financial system. After 2008, we avoided another Great Depression. In the immortal words of Gordon Brown, they saved the world . . . the world’s banking system. They deserve their prize.
But in 2022, are we really still vibing on loose monetary policy? Insert the “hmm” emoticon here.
Go with me on this. There’s a winding, multi-decade line between recognising bank runs in the 1980s, building out central bank independence in the 1990s, fighting a financial crisis in the 2000s, persistent low rates in the 2010s and Modern Monetary Theory (lol) in the 2020s. This winding line might even continue to who knows what crisis in the 2030s? If so, rinse and repeat.
Now, Bernanke’s often teased for blogging. But he’s absolutely no slouch. Quite the opposite. In 1995, he and Mark Gertler wrote a paper Inside the Black Box: The Credit Channel of Monetary Policy Transmission. The paper’s observation? Well, back then, conventional understanding of monetary policy transmission was inadequate. The paper’s conclusion? Fear not! Spend a little more time thinking about how credit and banking works and Bob’s your uncle. Very prescient. Certainly that work jived well with Diamond and Dybvig’s. As it turned out, credit and banking were central to the story of how finance and policy work.
Or, indeed, central to the story of how finance and policy don’t work.
Maybe think about it like this. The pre-2008 banking system captured the prerogatives of post-2008 monetary policy. How? Well, the banks created surplus credit. Call that period one. Then, in period two, the central bank had to create dollars to replace that lost liquidity. Look at that chronology through squinted eyes and you might see private banks, ultimately, creating policy dollars. The Fed was, ironically, merely the financial intermediary — the lender. Now whisper this question. Are the dollars that were created since 2008 to replace what was surplus credit before 2008 themselves now in surplus?
Perhaps. Perhaps not. Today’s strong dollar suggests otherwise. But it’s undeniable that we may have over-baked our monetary soufflé.
Was there ever an alternative to accepting that upcycles end in disaster? Was there ever a different approach to bank runs than lenders-of-last-resort, low rates, bailouts, QE, OMT, and a panoply of other acronyms? Given today’s inflation, we really have to ask. Maybe the banking sector should have had its own equivalent of an inflation target. What is the point of a 2 per cent target if the financial system can inflate itself at will? (OK, that would have been too much communism.)
Alternatively, what about letting the wildfire burn through the system in 2008, Ayn Rand style, and then picking up the charred pieces of Freddie and Fannie afterwards? (OK, that would have been too little communism.)
So all we really have to wonder is this: have we yet had the 2008 correction come through the system? Or have we figured out how to deal with bank runs and financial crises today at the expense of tomorrow? Answers, please, on a postcard.
Source: Economy - ft.com
